Wild days on Wall Street: Volatility rules

Feb 06, 2018
A trader works on the floor of the New York Stock Exchange in New York Feb. 6, 2018. MUST CREDIT: Bloomberg photo by Michael Nagle.

Two days of plummeting stock prices were reversed on Tuesday as the market bounced off a bad start and finished with a big gain.

From huge losses to big wins, the common thread is volatility and most analysts say the antidote to roller-coaster nausea is perspective: the stock market matters, but it is not the same as the economy, we are not in a recession and the immediate trigger was actually good news, not bad.

Still, the swings have been crazy-making.

“If you want to be good in the market, study mob psychology, don’t study economics,” said Sam Fraundorf, Atlanta-based chief investment officer of Diversified Trust. “A whole bunch of jittery investors can cause a stampede.”

The Dow Jones Industrial Average closed the trading day up 567 points after having started the day down about as much.

After years of a bull market – and many calm months of steadily climbing prices – the wild ride started Friday with a 665 point loss. Monday was worse: a plunge of 1,175 points.

But as the cliché has it, the market is not the economy. And falling prices have little direct impact on company profits or hiring or wages. Most long-term investors can wait out even the more traumatic-looking drops. And several experts told The Atlanta Journal-Constitution that they suspected much of the whip-sawing came because of computer programs that cascaded from one seller to another.

That doesn’t mean there is no message in the market and no link to the economy.

“As a long-term investor, I am not worried,” Fraundorf said. “But if you start to see the long-term investors lose confidence, then I would be worried too.”

People with longer perspective do not get too worried unless there are some “very quantifiable pieces of economic data” that signaled economic turmoil or recession, he said. “I don’t see that.”

After all, many experts have been saying for months that stock prices were too high and a sell-off was coming.

Since 1932, there has been a stock market drop of 10 percent or more an average of every 26 months, said Emily Sanders, managing director of United Capital Financial Life Management. “I’m not overly worried. We were really due.”

Experts define a bear market as a stock slide of 20 percent or more, she said. “And we are nowhere near a bear market.”

However, the many months of peaceful, steady price increases are over, Sanders said.

During periods when the market is sorting itself out, prices both plunge and soar – often on the same day, she said. Get used to it: “I would say it is very likely that we see heightened volatility the rest of the year.”

Most analysts view the economic backdrop as relatively benign: no recession, no financial crisis, no spiking energy prices, no immediate threat to peace.

Some even point to good news as the cause of the market meltdown. That is, low unemployment and higher wages raise expectations that the Federal Reserve will more aggressively lift interest rates, which tends to dampen the attractiveness of stocks.

Adding to that are the tax changes that will pump up the deficit by about $1 trillion. Because when all borrowers have to compete with the government, rates typically go up.

Even if the market turns down again Wednesday, that doesn’t mean a long-term trend, according to an analysis by Keith Lerner, chief market strategist of SunTrust Advisory Services in Atlanta.

During the past three decades, the stock market has hit a number of potholes, he said.

Concerns about wars, debt, politics and the economy sparked spikes in volatility, which often led to big drops in stock prices. In many cases, the market dropped for weeks or even months. But in only case was it still down a year later: the tumble that followed the collapse of Lehman Bros. in 2008.

Of course, that was a doozy. Before hitting bottom in mid-2009, the Dow had lost 42 percent of its value.

But that was during a vicious recession, a downturn that started with decay and bad debt that infested some of Wall Street’s leading firms and threatened the financial market itself.

“The selling this week appears more technical in nature than fundamental,” Lerner said. “Longer-term we expect markets to reconnect with fundamentals.”

And those fundamentals are solid, argued Jim Hansberger, managing director and private wealth advisor for Hansberger & Merlin at Morgan Stanley.

“We are talking about more consumer spending, more capital spending, more profits and more jobs,” he said. “Everybody’s asking questions, but has anything really changed? It is possible that eventually inflation and higher interest rates could choke off a recovery, but I can’t see that happening for quite a long time.”

Still, there are some who reject that conventional wisdom.

It’s “irrelevant” to talk about fundamentals, said economist James Galbraith at the University of Texas. “What matters for the economy going forward is not past performance but the balance of confidence and fear.”

The stock boom has depended too much on low interest rates, share buy-backs and a falling dollar – and those factors could now dissipate, Galbraith said. “If the Federal Reserve continues to raise interest rates, and even more so if it picks up the pace, the dollar will stop falling, and perhaps again start to rise.”

That doesn’t mean the economy is in trouble, he said. “The stock break does not by itself derail this goal for 2018, at least, not yet. But it makes clear that financial and economic risks, instabilities and crises have not gone away.”


A look at the big issues in the stock market gyrations

What does the recent drop say about the state of the U.S. economy?

Interestingly this correction, unlike the pullbacks we’ve seen over the past 9 yrs, is due to the fear of too much growth, rather than not enough growth. Most market pullbacks are due to fear of the economy slowing down which leads to lower/slower corporate profits. This recent sell off is due to a strong economy that’s getting stronger (unemployment at 4.1% and headed lower, wages growing at 2.9%+, a tight housing market, etc.)…and an economy that is too strong can lead to inflation. Inflation can in turn, push interest rates higher, the FED can quicken the pace of interest rate hikes…all leading to an economic slowdown. And that’s been the catalyst here…too much growth causing inflation fears, and fear of much higher interest rates. This could at some point, lead to the end of the current economic expansion cycle that we have seen since mid-2009.

What should mom and pop investors do right now?

Most investors should have a very long term time horizon about their stock and bond holdings. Long term means at least 10 years, and a 5 year outlook at minimum. As long as investors own a diversified mix of stock related assets (ETFs, mutual funds, etc.) and relatively short term bonds, then patience remains a virtue. Because the fundamental backdrop for the economy is healthy, long term investors should understand that staying the course in stocks, and even adding to stocks at times like this is usually the most profitable course of action.

Should those about to retire be worried about their 401ks?

Retirees always have to be more careful about their asset positioning and investment risk levels. I still believe that retirees should have some exposure to dividend paying stocks, but also have to remember that balancing this with safer and more stable assets (like Treasury bonds) is key. Should the retiree be worried? There’s no question that a market whipsaw is unsettling for most investors. However, as long as retirees are applying the fundamental principles of diversification and asset allocation, along with an eye on generating steady investment income, then their fear barometers should remain in check.

What do you think was the cause of the drop?

A combination of factors.

1. The worry of the US economy overheating, stoking inflation fears.

2. Rising interest rates that can make borrowing money for homes, autos, credit cards, etc. more expensive. 3. And, most importantly, profit taking due to a stock market that became overly placid and tranquil over the past two years. When markets go too long without any semblance of a correction (and we had gone over a year and a half without a 5% correction) traders become increasingly ready to head for the exits when a sell off does begin.

What do you think will happen next?

I think markets have finally awoken from their two year slumber. Volatility is now back. We will likely see more 1%+ daily market moves than we saw during 2016 and 2017. I also think that due to the fundamentally strong economic environment that we are in (and tax reform will boost both corporate profits and after-tax paychecks for Americans starting this month), this current correction should end up as a buying opportunity.

— Wes Moss, Chief Investment Strategist

Capital Investment Advisors and Wela